Chapter 5: Channels of Monetary Policy and Implications for the Euro
5.1 INTRODUCTION1 This chapter contributes to one strand of the empirical work drawn upon in Chapter 4, regarding the demand for money. The demand for money is an important variable to monetary policy as operated at the moment by the European Central Bank (ECB). The empirical properties of both the individual member states and the aggregate European Monetary Union (EMU) demand for money, would have to be closely monitored by the ECB. The literature on the demand for money in the EMU countries recognises that the conduct of monetary policy in a monetary targeting regime relies heavily and crucially on a stable demand for money along with theory-consistent interest elasticities. Otherwise, the transmission mechanism of monetary policy becomes uncertain. Similarly, when a combination of both monetary and direct inflation targeting is pursued, here again the conduct of monetary policy relies, to a very large extent, on the properties of the demand for money relationship in the member states of the EMU. The stability of the demand for money is regarded as the prerequisite to both regimes of targeting. However, when an inflation target is preferred to a monetary target, to be influenced by the rate of interest, the presupposition of a stable demand for money is not so crucial. Although money aggregates could potentially continue to provide information on inflation forecasts, this may not be deemed necessary by the Central Bank. The Bank of England, for example, does not consider such information as useful simply because there is the belief...
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